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A STUDY ON THE ROLE OF ACCOUNTING RATIO ANALYSIS ON BUSINESS DECISIONS IN NIGERIA
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
According to Igben (1999:423), “Accounting {or financial} ratio is a proportion or fraction or percentage expressing the relationship between one item in a set financial statements and another item in the financial statements. Accounting ratios are the most powerful of all tools used in analyzed and interpreting financial statements”. Therefore, ratio analysis involves taking stats of number (or items) out of financial statements and forming ratios with them, to enhance informed judgments and decisions (Lasher, 1997:66). MCShane et al. (2000:336) defined decision-making as “a conscious process of making choices among one or more alternatives with the interior of moving toward some desired state of affairs.” Therefore, business decisions can be defined as choices relating to the allocation and/or use of business resources to achieve business goals. Decision-making calls information. Bittel et al. (1984:340) observed: “Managers want information because they need to make decisions. The proper use of information is an important part of decision-making.” Remarkably, one of the effective ways of providing information needed for decision-making is ratio analysis. Yes, business decisions of make or buy, investment or divestment, expansion or contrition, capital-organization and reconstruction, and so on cannot be properly made without the aid of financial ratios. They give cue to the financial strengths and weaknesses of a business, and highlight aspects of a business requiring further investigation. Financial information provided in financial statements is useful in business decisions. However, it must be noted that financial statements are means to an end not an end in themselves. Thus the use of financial statements in decision-making is not always easy owing to the problem of summarized nature of the information contained in financial statements, they need to be analyzed and interpreted by means of financial ratios to enable management and stakeholders understand them and make well-informed business decisions. Therefore, this research paper is carried out to show how ratio analysis help managers, shareholders, investors, creditors, and other stakeholders make informed judgments and decisions about the past performance, present condition, and futures potential of a business.
Financial ratios are useful indicators of a firm’s performance and financial situation. They are the most powerful of all the tools used in the analysis and interpretation of financial statements. Financial ratios can be used to analyze trends and to compare the firm’s financial performance to those of other firms. In some cases, ratio analysis can be used to predict future trend. However, the determination of appropriate standard against which a company’s ratio may be compared is often a difficult problem for financial analyst (Igben, 2009). To overcome this problem, a firm’s financial ratio may be compared against the ratios of other firms in the same industry. Financial ratios serve as important tool of evaluating the performance and financial conditions of a business entity over a period of time, empirical studies like Chen and Shimerda (1981) and Igben (2009) demonstrated the usefulness of financial ratios in this regard. Chen and Shimerda, (1980) captured the value of the accounting ratios when they averred that financially distressed firms can be separated from the non-failed firms in the years before the declaration of bankruptcy at an accurate rate of better than 90% by examining financial ratios Financial ratios are tools of financial analysis. In financial ratio evaluation is normally done using the financial information generated by the firm. However, financial ratios can be classified according to the information they provide. The frequently used ratios are Liquidity Ratio, Asset Turnover Ratio, Financial Leverage Ratio, Profitability Ratio and Dividend Policy Ratios. The profitability ratio which is the major ratio for analysis in this study as a measure of performance can assist in determining the different level of success of the firms at generating profit. The objective of the study is to measure the financial performance of commercial banks using financial or accounting ratios, the study also seek to examine the effect of liquidity, credit risk, capital, operating expenses and the size of banks on their financial performance using accounting ratios.
1.2 Statement of the Problem
The financial sector consist of strings of financial activities whose major end is profit making, over the years the means and manner of measuring this financial performance remain issue of concern, the variables to use in the measurement of this performance is germane to growth and stability, the issue therefore is determining the variables to use in financial performance measurement and how well do these variables can measure the performance in the financial sector in the financial sector major identified measure of performance include size, capitalization, credit risk, operating expenses or liquidity as far as the banking sector is concern. The extent to wish each of these variables and indicators measure the performance over time is an issue of concern and factor to bed evaluated therefore it is the focus of the study to examine the extent and how effective these variables measure performance in the banking industry.
1.3 Objective of the Study
The main objective of the study is to find out the role of accounting ratio analysis on business decisions in Nigeria, specifically the study intends to;
1. Measure the financial performance of commercial banks using financial or accounting ratios
2. Examine the effect of liquidity, credit risk, capital, operating expenses and the size of banks on their financial performance using accounting ratios
3. To find out if financial ratio helps to unravel the mass of truth hidden in financial statements.
1.4 Research Questions
1. Does financial performance of commercial banks increase using financial or accounting ratios
2. What is the effect of liquidity, credit risk, capital, operating expenses and the size of banks on their financial performance using accounting ratios
3. Does financial ratio helps to unravel the mass of truth hidden in financial statements
1.5 Significance of the Study
The study will help management of banks and other business organizations to know how ratio analysis can help them understand the financial contained in financial statements and enhance their business decisions.
The findings of the research and the supportive reference materials will be of immense help to students in tertiary institutions and other researchers to investigate further in the area of study.
It is hoped that the result of the research will facilitate optimal business decisions when the recommendations are complied with.
The study will encourage businessmen, investors, managers, and government authorities to appreciate quantitative techniques like financial ratios when making economic and business decisions.
1.6 Scope of the Study
The study concerns about accounting ratios as a tool for management decision making with a particular reference to first bank Plc.
1.7 Limitation of the Study
The challenge of finance for the general research work will be a challenge during the course of study. However, it is believed that these constraints will be worked on by making the best use of the available materials and spending more than the necessary time in the research work. Therefore, it is strongly believed that despite these constraint, its effect on this research report will be minimal, thus, making the objective and significance of the study achievable.
1.8 Definition of Terms
Ratio: A ratio can be defined as the indicated quotient of to mathematical expression and as the relationship between two or more things.
Ratio Analysis: It is defined as the systematic use of ratio to interpret the financial statements so that the strength and weaknesses of a firm as well as its historical performance and current financial condition can be determined. The term ratio refers to the numerical or quantitative relationship between two variables.
Accounting: It is the process of recording, summarizing, analysis and interpreting financial (money-related) activities to permit individuals and organizations to make informed judgments and decisions.
Business: It is an activity of enterprise or organization established to provide goods and services at a profit, in order to satisfy human wants.
Business Decision: The choices made on matters relating to the allocation and/or use of business resources for making, buying, selling, or supplying goods or services at a profit.